TickerVue — Eyes on the Market

Chapter 4: Equities Mechanics

“It is literally true that millions come easier to a trader after he knows how to trade, than hundreds did in the days of his ignorance.”
— Jesse Livermore, stock trader

It should go without saying, but any success that an individual might have in the implementation of their trading and investing strategies is predicated upon actually knowing how to trade. This may appear to be axiomatic in meaning, but it is not. Knowing how to trade, in this context, is not analogous to the mastery of trading stratagems that Jesse Livermore spoke of in the quote above. It is, instead, a reference to a knowledge of trading mechanics. This chapter will discuss where equities are traded, through what mechanisms they are traded, and how to place an order to buy or sell a stock.

Broker Dealers and Market Access

Institutional and professional traders have multiple options when sending orders. Broker-dealers (BDs) must subscribe to specific market centers for traders to participate in them. The available trading venues depend on the broker one chooses, as not all brokers subscribe to an extensive range of options due to the associated costs.

What is an Exchange?

An exchange is a marketplace where securities, commodities, derivatives, and other financial instruments are traded. The primary function of an exchange is to ensure fair and orderly trading while providing efficient dissemination of price information for securities. There are ten major exchanges utilized by professional traders.

Major Exchanges Used by Professional Traders

NYSE – New York Stock Exchange
AMER – NYSE American, formerly AMEX, acquired by NYSE Euronext in 2008
NSDQ – NASDAQ – National Association of Securities Dealers Automated Quotations
ARCA – NYSE Arca, formerly Archipelago Exchange, merged with NYSE in 2006
EDGA – Cboe EDGA Exchange
EDGX – Cboe EDGX Exchange
BATS – BATS Global Markets, formerly Better Alternative Trading System
MIAX – Miami International Securities Exchange
MEMX – The Members Exchange, founded by nine major banks
IEX – Investors Exchange

NYSE Stocks and Trading Options

All NYSE-listed stocks trade on the NYSE exchange, but they can also be traded on other exchanges and alternative trading systems. The ability to access these options depends on an individual's broker-dealer, as they may not subscribe to all available venues due to costs.

What is an Alternative Trading System (ATS)?

An alternative trading system (ATS) is a non-exchange trading venue that facilitates the buying and selling of securities, typically outside of traditional stock exchanges like the NYSE or NASDAQ. Defining characteristics of alternative trading systems include:

They are regulated under the securities law of the United States.
They must register with the Securities and Exchange Commission (SEC) and comply with Regulation ATS.
They provide electronic platforms for matching buy and sell orders.
They often cater to institutional investors seeking privacy, better execution and reduced market impact.
They offer customizable order types and execution strategies not always available on public exchanges.

The purpose of alternative trading systems is to facilitate the off-exchange trading of securities. Order matching services are administered with price-time priority and use auctions or hidden liquidity pools. This liquidity provision is one of the features that attracts institutional investors and market makers. They also provide anonymity and reduced market impact for large institutional trades, which prevents them from impacting market prices. They offer flexibility in order execution and order parameters, such as time-in-force and pegged orders.

There are a myriad of types of securities that can be traded on these systems, including equities, bonds and other debt instruments, derivatives, and, in select jurisdictions, cryptocurrencies. Alternative trading systems are particularly useful for trading small-cap equities and other illiquid stocks.

Benefits and Challenges of Alternative Trading Systems

Benefits

Lower Transaction Costs: Alternative trading systems are generally cheaper compared to traditional exchanges.
Reduced Market Impact: Large trades are executed with minimal price disturbance.
Extended Trading Hours: Many alternative trading systems offer extended trading hours, offering their users the ability to trade after the market closes.
Algorithmic Efficiency: They allow algorithms to execute orders in an efficient manner.

Challenges

Lack of Transparency: Particularly dark pools, which offer limited visibility into order flow.
Conflicts of Interest: Some alternative trading system operators may prioritize certain clients over others.
Regulatory Scrutiny: Increasing oversight to ensure fair trading practices.

Types of Alternative Trading Systems

Over-the-Counter (OTC): Over-the-Counter is the trading of securities that does not take place on a formal exchange. It can take place either directly between private parties or through broker-dealer networks. These decentralized markets are much more loosely regulated than are formal exchanges.
Dark Pools: A dark pool is a private venue that allows large trades without public disclosure. This minimizes market impact.
Electronic Communication Networks (ECNs): An electronic communication network is a digital system that automatically matches buy orders and sell orders for a security. They are particularly beneficial for traders and investors in different geographic regions looking to execute a secure transaction without the use of a third party.
Crossing Networks: A crossing network is a digital system that matches orders at specific intervals without exposing order details. They are quite similar to dark pools, as there is no public disclosure, which minimizes market impact.

Alternative Trading Systems Regulation and Compliance

Regulations pertinent to maintaining compliance for alternative trading systems, including Regulation ATS, dictate that:

An alternative trading system is a trading system that meets all of the criteria of an “exchange” under federal securities laws, but is not required to register as a national securities exchange if the alternative trading system operates under the exemption provided under Exchange Act Rule 3a1-1(a).
In order to comply with Regulation ATS, an alternative trading system must, among other things, register as a broker-dealer and file an initial operation report with the Securities and Exchange Commission on Form ATS before commencing operations.
They must be a member of the Financial Industry Regulatory Authority (FINRA).
They must comply with anti-fraud regulations.
They must comply with fair access provisions.
They must acquiesce to periodic reporting and audits.

Dark Pools

Dark pools are private trading venues where institutional investors can trade large quantities of securities without publicly disclosing trade details such as price and volume. These private exchanges prevent significant market impact and allow for discreet execution.

Major Dark Pools

MS Pool – Morgan Stanley
Sigma X – Goldman Sachs
LX Liquidity Cross – Barclays Capital
BIX – BNP Paribas
Citadel Connect – Citadel
JPMX – JP Morgan
Citi Match – Citi
SuperX ATS – Deutsche Bank Global Markets
GETMatched – GETCO
Knight Link & Knight Match – Knight Capital Group
Instinct-X – Merrill Lynch
Nomura NX – Nomura
UBS ATS, UBS MTF & UBS PIN – UBS Investment Bank
Lime Trading Corp.
Alpha Y – Societe Generale

Dark Pool Order Execution Strategies

There are a number of strategies that can be implemented in order to execute orders in dark pools. Lime Trading offers a number of strategies, which include:

Smart Router: Prioritizes speed and visible liquidity while accessing displayed and non-displayed markets.
Dark Sweep Algorithm: Optimizes liquidity sourcing with low transaction costs.
Hidden Orders: Accesses dark pool liquidity and posts hidden orders on lit venues.
VWAP (Volume-Weighted Average Price): Minimizes slippage against the market's VWAP.
TWAP (Time-Weighted Average Price): Minimizes slippage against the TWAP over the order duration.

There are numerous alternative trading systems and dark pool options available, each with specific order types and execution strategies. Not all brokerages provide access to the same venues and order types.

Level 1

The main tool for placing a trade is a montage. It consists of three parts: the Level 1, the Level 2, and the Level 3.

The Level 1 in a trading montage provides the most basic market data. It is typically available to all traders. It includes:

Best Bid and Ask Prices: The highest price a buyer is willing to pay (bid) and the lowest price a seller is willing to accept (ask).
Last Traded Price: The price at which the most recent trade occurred.
Trading Volume: The number of shares or contracts traded during the session.
Bid/Ask Size: The number of shares or contracts available at the best bid and ask prices.
Opening Print: First trading print of the current session.
Previous Close: The last trading print of the previous session.
High: The highest print of the current trading session.
Low: The lowest print of the current trading session.
Net Change: Difference in price between the Last Traded Price and the Previous Close price.
Net Percent Change: The percent by which the Last Traded Price has increased or decreased relative to the Previous Close price.

Level 1 data is useful for general trading, but lacks market depth. It does not show multiple bid/ask levels, like Level 2 data does, nor does it provide order modification access, like Level 3 data does. It is typically included in standard brokerage accounts and used for basic trade decisions.

Key Definitions

Bid: A bid is the price at which a market maker, a trader, or an investor is willing to purchase a share of equity (or any other security).
Ask: An ask is the price at which a market maker, a trader, or an investor is willing to sell a share of equity (or any other security).
Bid/Ask Spread: The bid/ask spread is the difference between the lowest price a seller is willing to sell a security and the highest price at which a buyer is willing to purchase that security. The highest bid and lowest ask make up the National Best Bid and Offer price (NBBO).

Level 2

Level 2 data in a trading montage provides market depth information by displaying the order book beyond just the best bid and ask prices. It is commonly used by active traders and includes:

Market Depth (Order Book): Shows multiple bid and ask price levels, typically the top 10-20 price levels on both sides.
Market Participants: Identifies the market makers, electronic communication networks, or liquidity providers placing orders at each price level.
Liquidity Insights: Helps traders gauge supply and demand by seeing where large orders are sitting.
Order Flow Analysis: Useful for predicting short-term price movements based on where buyers and sellers are stacking orders.

Unlike Level 1 data, which only shows the best bid and ask price with the last trade, Level 2 provides a broader view of market sentiment and potential price movements. However, it does not allow direct order modification like Level 3 data, which is reserved for market makers and professionals with exchange access.

Level 3

Level 3 data in a trading montage refers to the most detailed market data available. It is typically used by market makers, proprietary traders, and institutions. It provides full-depth-of-book information, including:

Full Market Depth: Displays all buy (bid) and sell (ask) orders at every price level, not just the top 10-20 levels seen in Level 2.
Market Maker & ECN Identifiers: Shows which market participants (banks, brokers, high-frequency traders, ECNs) are placing orders at each price level.
Order Entry & Modification: Allows users to directly enter, modify, or cancel orders in real time.
Time & Sales (Trade Tape): Lists executed trades, their sizes, and the execution venue.
Order Routing & Direct Market Access (DMA): Enables traders to route orders directly to specific exchanges, ECNs, or dark pools.

Retail traders usually have access to Level 1 data (best bid/ask) or Level 2 data (depth of market with multiple bid/ask levels). Level 3 data is generally reserved for professionals with exchange memberships.

Full trading montage with order execution, depth of book, and time & sales

Placing a Trade

The process of placing a trade on a professional trading platform begins by filling out an order ticket. If it has been programmed, a hotkey can also be used to place a trade. Hotkeys are preprogrammed orders that can be set up on many trading platforms. The steps to place an order are as follows:

Type in a symbol. This example will use the symbol “A” (Agilent Technologies).
Choose a Market Center. This example will use NYSE as the route. Most professional traders look for liquidity, so they often select a venue that will have enough size to fill their order.
Enter the desired price. This example will buy the offer price of $150.73.
Enter the desired quantity. This example will buy 100 shares.
Select whether or not to display the full size of the order. If the stock is very liquid and has a high amount of daily volume, or the quantity of shares in an order is relatively low, it is perfectly fine to leave this at “All”, which will display the full order.
Market order check box. This example will leave it unchecked, as a market order is not being placed. Most professional traders rarely, if ever, place market orders.
Select whether or not the order is directed. This example will not direct the order, but if a stock has a wide spread between the bid and the ask, directing the order to “MID” may be able to secure a better price.
TIF (Time in Force). This example will use “DAY”, as it is being placed during market hours. Other options include IOC (Immediate or Cancel) and Extended (for pre/post market hours).
Click the “Buy” button on the top of the order ticket.

Order ticket with Buy button highlighted

At this point, the order would be sent and likely filled.

Market Order

A market order is a financial markets direction that instructs a brokerage to buy or sell a financial security at the best available price in the current financial market. A buy market order will purchase a security at the lowest available offer. A sell market order will sell a security at the highest available bid. As there is no requirement that the price of the security must meet, market orders should always be filled almost instantaneously.

Limit Order

A limit order is a financial markets direction that instructs a brokerage to buy or sell a financial security at a specified price or better. A buy limit order will purchase a security at the specified price or lower. A sell limit order will sell a security at the specified price or higher. These orders will only be executed if the price meets the order qualifications, so it is not guaranteed that such orders will be filled. Most professional traders use limit orders most of the time.

Stop Order

A stop order is a financial markets direction that becomes active once a specified pre-set price level is breached. A buy stop order will instruct a brokerage to purchase a security once the security has traded at the specified price or higher. A sell stop order will instruct a brokerage to sell the security once the security has traded at the specified price or lower. A stop order can be immediately marketable, similar to a market order, or have a limit with respect to how far beyond the specified price the trader is willing to transact at, similar to a limit order.

Types of Stop Orders

Stop-Loss Order: A stop order that is used to exit a position. If a trader is long a stock, a stop-loss order would sell those shares if the price of the stock went below a certain level. Conversely, if a trader was short a stock, a stop-loss would cover (buy) those shares if the price of the stock went above a certain level.
Stop-Entry Order: A stop order that is used to enter a position. If a trader is not long a stock, but would want to be long that stock in certain conditions, a stop-entry order would buy shares of that stock if the price went above a certain level. Conversely, if a trader was not short a stock, but would want to be short that stock in certain conditions, a stop-entry order would sell shares if the price went below a certain level.
Trailing Stop-Loss Order: A stop order that is used to exit a position. Unlike a regular stop-loss order, which is set at a specific price and does not change, a trailing stop-loss order will change with the success of a trade. A trailing stop will shift as an offset of the maximum unrealized gain of a trade. If a stock is purchased at $300.00 and a trailing stop-loss order of $0.80 is entered, if the stock reaches $302.00, the stop-loss would be triggered at $301.20. If the stock then went up to $304.00, the stop-loss would move to $303.20.

Trade Through / Sweep Key

A trade through key is a hotkey that can typically be used with any electronic communication network. It allows a trader to set an amount or percentage by which they are willing to buy above the ask or sell below the bid in order to get their order filled. This function can be used on both the buy side and the sell side.

If a trader is long 500 shares of stock “A” and the market begins to turn quickly, so the trader wants to exit their position quickly, they could do so using a trade through key. If the bid is $150.61 and the trade through key is set to $0.10, the order would be filled down to a price of $150.51, if there is enough liquidity. In this example, the order would fill 400 shares at $150.61 and 100 shares at $150.60.

Level 2 showing bid prices for trade through

Hitting the Bid or the Offer

A hotkey can be created to either enter a limit order at whatever price the bid currently is or to enter a market order.

ECN Specific Keys

Electronic communications network specific keys can be created for various trading needs depending on your trading style and the ECNs available through your broker.

Halts

If trading in a stock should be halted, it would require a hotkey specific to the primary exchange that the stock trades on in order to trade that stock as it emerges from the halt.

On-Open / On-Close

These allow a trader to place an on-open or an on-close order to ensure that the trader receives either the first or final print of the day.

TWAP or VWAP

A TWAP order is a time-weighted average price order, while a VWAP order is a volume-weighted average price order. This order type allows a trader to get out of a position within the parameters of these orders.

Trading Imbalances

These types of orders are somewhat complicated and not all traders have access to them or the data necessary to use them effectively. However, they are, in essence, used to buy or sell on the open of the market and the close of the market.

Midpoint Order

A “midpoint order” is an order that is sent out to the midpoint of the bid-ask spread. Traders will often, but not always, get filled at a price between the best bid and offer price. This strategy seeks price improvement by obtaining a more favorable rate than simply buying at the National Best Bid and Offer price.

Chapter 5: Options Mechanics

“A derivative is a bet on whether a stock, or a bond or a real estate asset, is going to go up or down. There's a winner and a loser. It's like betting on a horse race.”
— Michael Hudson, economist

While there were a myriad of types of option derivatives introduced in the third chapter of this course, the focus of this chapter will be far more narrow. This is because there are only two types of options that are particularly relevant to the vast majority of traders and investors. These are vanilla calls and vanilla puts. Most of the exotic options introduced in the third chapter are typically only available to institutional traders.

Vanilla calls and vanilla puts, or, more specifically, American style calls and puts, typically trade on the Chicago Board Options Exchange (Cboe). There are substantial and highly liquid markets for these instruments, enabling traders and investors of all stripes to easily utilize them in their strategies. However, before options can be utilized within a strategy, the procedural incidentals for trading options must be established. This chapter will discuss the mechanics of options: their availability, their functionality, their pricing, and how to place an order to buy or sell an option or an options spread.

Key Definitions

Chicago Board Options Exchange (Cboe): The world's largest options exchange. Founded in 1973 by the Chicago Board of Trade, it has contracts that cover individual equities, exchange traded funds, exchange traded notes, indexes, interest rates, and even volatility.
Options Spread: A type of strategy that involves the purchase of one or more calls or puts and the shorting of one or more different calls or puts for the same underlying security. The options can differentiate along the lines of whether they are calls or puts, their strike price, or their date of expiration.
Debit: A debit occurs when the total premium of the options purchased in an options spread is greater than the total premium of the options sold in that spread. The trader purchases a spread hoping that the value of the spread increases prior to expiration.
Credit: A credit occurs when the total premium of the options purchased in an options spread is less than the total premium of the options sold in that spread. The trader sells a spread hoping that the value of the spread decreases prior to expiration.

Options Chains

In order to trade calls and puts, a trader or investor must know what calls and puts are available to trade. Not every equity or exchange traded fund will have options that expire on the same dates or have the same strike prices. Some do not have any option contracts associated with them at all. To find out what calls and puts are available to trade, one must view an options chain.

An options chain is a list of all available call contracts and put contracts available for a specific security. They are organized first by date of expiration and then by strike price. For each contract an options chain will typically display the bid price, the ask price, the last traded price, the volume traded for the current or most recent market session, and the open interest.

Most brokerages in the United States should provide options chains for all securities for which the Chicago Board Options Exchange provides quotes. Securities that have a high trading volume or have derivatives that have a high trading volume will typically get more expiration dates and more strike prices.

Expiration Frequencies

Yearly options: Expire on the third Friday of December each year.
Quarterly options: Expire on the third Friday of the third month of each financial quarter (March, June, September, and December).
Monthly options: Expire on the third Friday of each month.
Weekly options: Expire on Friday each week.

Due to extremely high demand and tremendous volume for contracts for certain exchange traded funds that track prominent indices, these securities have options chains with expiration dates on every Monday, Wednesday, and Friday – and in recent years, contracts that expire every session.

Key Options Chain Terminology

Strike Price: The price at which the holder of a call can buy the underlying asset or the holder of a put can sell the underlying asset.
Expiration Date: The last trading session that an options contract is valid.
Bid Price: The highest price at which a market maker, trader, or investor is willing to pay to purchase an option contract.
Ask Price: The lowest price at which a market maker, trader, or investor is willing to receive for selling an option contract.
Last Price: The most recent price at which a transaction for an option contract occurred.
Volume: The number of contracts that have traded in the current or most recent market session.
Open Interest: The total number of outstanding option contracts for a security that have not been settled. Open interest increases when traders initiate a position and decreases when they close out a position.

The Greeks

Many brokerages and trading platforms will offer information in their options chains, or elsewhere, about an options contract beyond its bid price and ask price. They will include the factors that contribute to the determination of a bid price and ask price. These contributing factors are commonly known as the “Greeks”. The Greeks are an assessment of risk in an option or an options position. They measure the sensitivity of the price of an option, both to its underlying and to a multitude of other determining parameters.

While there are over a dozen Greeks, when traders and investors mention the Greeks they are typically referring to five of them: delta, gamma, theta, vega, and rho. The remaining Greeks are derivatives of these five Greeks or a derivative of a different Greek that is itself a derivative.

The significance of the Greeks and their effects on the prices of options was codified in 1973 by the financial economists Fischer Black and Myron Scholes. In their seminal article “The Pricing of Options and Corporate Liabilities” in the Journal of Political Economy, they introduced what would later be termed the “Black-Scholes options pricing model”. This is a multivariate function that yields an estimate for the price of European-style options. It shows that options have a unique price tied to the risk of the derivative and its expected return. In this context, the Greeks represent the sensitivity of this partial differential equation to changes in its parameters.

First Order Greeks

First order Greeks are the Greeks that are not a derivative of any other Greek. Rather, they are the Greeks that all of the other Greeks are derived from. They are the sensitivities to different factors of the price of an option and they play an important role in the Black-Scholes model.

Delta: The most frequently considered of all of the Greeks. It measures the rate of change of the value of an option with respect to change in the value of the underlying asset. For a long call, delta will almost always be between 0.0 and 1.0, while for a long put, delta will almost always be between -1.0 and 0.0. If a long call is at-the-money, it will likely have a delta of around 0.5. This means that if the price of the underlying asset increases by $1.00 per share, the price of the call will increase by $0.50 per share.
Vega: Measures the sensitivity of the price of an option to the volatility of the underlying asset. It is often expressed as the change in the price of an option for every one percentage point of increase to the implied volatility of its underlying asset. If a long call had a vega of 0.25 and the implied volatility increased from 15.00% to 20.00%, the price of the call would increase by $1.25. Vega typically increases the closer the option is to being at-the-money, as well as the more time till expiration.
Theta: Measures the rate of decline in the value of an option over time. It is usually expressed as a negative number for long call and put positions, but as a positive number for short positions. Theta is typically thought to be the amount that the value of an option will decrease each day. If an option has a theta of -0.10, the value of the option will decrease by $0.10 per share per day. Theta is highest for options that are at-the-money.
Rho: Measures the change in the price of an option relative to a change in the risk-free interest rate. A call will generally have a positive rho and will increase in value as interest rates increase, while a put will generally have a negative rho. Rho increases as an option gets closer to being at-the-money and decreases as the contract draws nearer to expiration.
Epsilon (Psi): Measures the sensitivity of the value of an option to changes in the dividend of the underlying asset. It represents the price change of an option contract relative to the change in the dividend yield. For long call positions it is negative, while for long put positions it is positive. It is the least utilized among the first order Greeks.

Second Order Greeks

Second order Greeks are the Greeks that are derived directly from the first order Greeks. While first order Greeks are the sensitivities to different factors of the price of an option, second order Greeks are the sensitivities of first order Greeks to shifts in various factors. With the exception of gamma, they are much less commonly considered by traders and investors than the first order Greeks.

Gamma: A derivative of delta. It is the only Greek, that is not a first order Greek, to be frequently utilized by traders and investors. It measures the rate of change in the delta of an option relative to a move in the price of the underlying asset. The range for gamma is 0.0 to 1.0. If the delta of a call option was 0.25 and the gamma was 0.05, if the price of the underlying asset increased by $1.00, then the delta of the call would increase to 0.30.
Lambda (Omega) (Elasticity): Measures the price sensitivity of an option relative to changes in implied volatility as a means of assessing how levered the option position is. If a trader owns 20 call contracts bought at $2.50 per share with a delta of 0.40, and the underlying stock increases by 1.00%, the value of the position would increase 16.00%. The lambda of this position is thus 16.00.
Gearing: Not technically a Greek, but a methodology of measuring the leverage that an option provides. It entails dividing the price of the underlying stock by the price of the option (on a per share basis).
Vanna: A derivative of delta. Measures the sensitivity of the delta of an option relative to the implied volatility of the underlying asset. If positive, an increase in volatility will lead to an increase in the delta of an option.
Charm (Delta Decay): A derivative of delta. Measures the sensitivity of the delta of an option relative to the time till expiration. The unit of measurement is the amount that the delta will change for a one-day decrease in time till expiration.
Vomma (Volga): A derivative of vega. Measures the sensitivity of the vega of an option relative to changes in the implied volatility of the underlying asset. If positive, when implied volatility increases, the vega of the option would increase.
Veta (Vega Decay): A derivative of vega. Measures the sensitivity of the vega of an option relative to changes in the time till expiration. A positive veta would indicate that the vega of an option increases over time.
Vera (Rhova): A derivative of rho. Measures the sensitivity of the rho of an option relative to changes in the implied volatility. It is a relatively recent addition to the Greeks, given a name only in 2012. It is the least utilized among second order Greeks.

Third Order Greeks

Third order Greeks are Greeks that are derived from the second order Greeks. They measure the sensitivity of the second order Greeks to shifts in various factors. While quantitative analysts might occasionally utilize them, there are no third order Greeks that are commonly considered by most traders or investors.

Speed (DgammaDspot): A derivative of gamma. Measures the sensitivity of the gamma of an option relative to changes in the price of the underlying asset. The greater the speed, the more sensitive the gamma is to changes in the price of the underlying.
Zomma (D-gamma) (D-vol): A derivative of gamma. Measures the sensitivity of the gamma of an option relative to changes in implied volatility of the underlying asset.
Color (Gamma Decay) (DgammaDtime): A derivative of gamma. Measures the sensitivity of the gamma of an option relative to changes in the time till expiration. The unit of measurement is the amount the gamma will change for a one-day decrease in time till expiration.
Ultima (DvommaDvol): A derivative of vomma. Measures the sensitivity of the vomma of an option relative to changes in the implied volatility of the underlying asset.
Parmicharma (DcharmDtime): A derivative of charm. Measures the sensitivity of the charm of an option relative to changes in the time till expiration.

Exercising Options and Assignment of Options

In the realm of vanilla options, call contracts give their owner the right to purchase the underlying asset at the specified strike price by a certain date, while put contracts give their owner the right to sell the underlying asset at the specified strike price by a certain date.

For European options, the right to buy or sell the underlying asset can only be exercised at the moment of expiration. For American options, however, the right to buy or sell the underlying asset can be exercised at any point up to the moment of expiration. Most options with equities and exchange traded products as their underlying assets are American options, while most options with an index serving as the underlying, and are thus cash-settled, are European options.

If the holder of an option contract exercises their right, a party that is short the contract will be obligated to fulfill the other side of this agreement. The assignment of options obligations is determined by the clearinghouse of the Chicago Mercantile Exchange, CME Clearing. This organization uses an algorithm to randomize the process of allocating assignment.

If an option expires in the money, the options are automatically exercised, unless otherwise instructed, and assignment and delivery of the shares would occur in the pre-market of the next market session. Option holders typically have until 5:30 PM EST on the day of expiration to exercise a contract, even if it expired out of the money.

Key Definitions

Equity Option: An option derivative that gives its owner the right, but not the obligation, to purchase or sell shares of a specific company for a specified price by a certain date. Most equity options entitle their holder to 100 shares of the underlying company stock.
Exchange Traded Product Option: An option derivative that gives its owner the right to purchase or sell shares of a specific exchange traded product for a specified price by a certain date. They function in the same manner as equity options.
Index Option: An option derivative that gives its owner the right to purchase or sell the value of an underlying index at a specified price by a certain date. Unlike equity options, index options have no underlying asset and are cash-settled.
Cash Settlement: A form of settlement for derivative trades for which physical delivery of an underlying asset or a security is either not required or impossible. If a cash-settled derivative expires in-the-money, those who are short pay the difference between the strike price and the current price.
Exercise: To put into effect the ability to buy or sell the underlying asset at the specified price detailed in the option contract.
Assignment: What occurs when the owner of an options contract exercises that option and assigns to a party that is short the contract the obligations required to complete the contract.
Write: To enter a short position in an option contract. When a trader writes a contract, they receive a premium in exchange for the possibility of having to meet the obligations specified in the contract.
Clearinghouse: An institution that acts as an intermediary between parties to a transaction in financial markets. They are the buyer to every seller and the seller to every buyer when financial securities are traded.

Option Order Entry

There are a large number of brokerages that offer options trading services. Almost all of the dozen or so online brokerages that are popular in the United States provide a platform with options trading capabilities. The Chicago Board Options Exchange even offers their own trading platform called Silexx. This chapter will show how to put in an order for an equity option on the platform of one of the largest and most popular brokerages in the United States, Charles Schwab.

Enter the locator tool for option chains.
Enter the ticker symbol of the underlying equity for the trade into the search bar. This example will use $AAPL.
Assess the option chain of the chosen underlying equity for the trade.
Select the expiration date, out of those available, for the trade. This example will use the monthly options for $AAPL that expire in 27 days from the time of the trade, on April 17, 2025.
Select the strike price, out of those available, and whether it will be a call or a put for the trade. This example will show a cash-secured put at the strike price of $180.00. Click on “More” and select “Sell Option”.
Enter or select the requisite information into the order ticket. Much of this will be auto-filled due to the steps previously taken. This example will trade one contract, use a limit order, limit the price received to $0.37 per share or greater (the current bid price), and will have a Time in Force of till the end of the current market session. While equity options typically represent the right to 100 shares, prices are displayed and entered on a single-share basis.
Select “Review Order” and on the next page, after verifying the order is as desired, select “Place Order”.

At this point, the order would be sent and likely filled.

Option Spread Order Entry

While buying or selling a single put or call is certainly a common method for trading options, there are dozens of options trading strategies available that both professional money managers and retail traders use regularly. These strategies can be used to limit risk, construct a payoff structure, or yield a specific degree of directional exposure to the underlying asset. Options spreads must be utilized in order to achieve this level of precision.

This example will show how to put in an order for an equity options spread on the Charles Schwab brokerage platform:

Enter the locator tool for option chains.
Enter the ticker symbol of the underlying equity for the trade into the search bar. This example will use $AAPL.
Assess the option chain of the chosen underlying equity for the trade.
Select the expiration date, out of those available, for the trade. This example will use the monthly options for $AAPL that expire in 27 days from the time of the trade, on April 17, 2025.
Select the strike price of one of the options that will be in the spread. This example will show a call vertical spread utilizing the call at the strike price of $230.00. Click on “More” and select “Buy Option”.
Enter or select the requisite information into the order ticket. First, select “Vertical Call” under the strategy section. As “Buy Option” was selected for the $230.00 call, that will be auto-filled, but the call that was auto-filled to be sold against it may not be the correct one. Choose the correct strike price for the option in the row with “Sell to open” on the left. Make sure the quantity of contracts is the same for both positions. Each position will not be transacted individually, but rather the difference between what is paid for the options that are bought and the amount that is received for the options that are sold will determine the outlay or influx of capital. In this example, the call that is bought is $0.59 per share more expensive than the call that is sold, so the account will be debited $0.59 per share.
Select “Review Order” and on the next page, after verifying the order is as desired, select “Place Order”.

At this point, the order would be sent and likely filled.